Forex Trading: Concept of Margin in the Forex Market

Introduction

The forex market is among the financial markets that provide trading on the aspect of margin using a Forex margin account. A lot of investors and traders are lured to the forex market due to the comparatively high leverage that brokers in the forex market offer the new investors.

Definition of margin

Trading on margin can be defined as using the money borrowed from forex brokers to trade in the market to substantially increase the investor’s presence in the forex market. Therefore when a trader opens a margin trade, the broker of choice will lend the trader a particular amount of financial backing; the money is dependent on the ratio of leverage that is used. The broker will then allocate a certain portion of the market account that will account as the collateral for the loan; this scenario is what is termed as the margin of the trade. 

Margin Definition to the Forex Trade

As stated earlier, trading on margin relates to an investor using borrowed money from a broker in performing forex market trades. Every instance the trader opens a trade on margin, the particular broker will instantly provide the desired margin from the trader’s existing fund in the trading account to support the margin trade. As stated earlier, the exact amount of financial backing that is allocated is dependent on the ratio of leverage used on that particular account.

Relationship between margin and leverage in forex trade

In the first instance, the trader opens a forex trading account with a broker, there is a high probability of observing the available leverage ratios that are provided by the broker. Numerous brokers make use of these leverage ratios for marketing purposes; a bigger leverage ratio enables the trader to open a much larger position size on the market than the actual trading account can allow.

There are however higher leverage ratios that are used; these ratios ascertain the position size the trader is allowed to take based on the size of the particular trading account. The higher the ratio of leverage that is used, the less the margin that is needed to make a trade.

Risk with Leverage

The question arises as to why not use the highest leverage ratio in the trade for a super decreased margin requirement, therefore, get tremendously high exposure to the market. The answer to this question can be better answered through Forex Risk Management. The concept states that leverage magnifies the potential profit as well as the potential of acquiring losses; it is therefore recommended not to use the highest leverage ratio. Visit https://mytradingtools.com/forex-diamond/ to understand how Forex Diamond provide you consistent profit while managing the risk you allowed.

Elements of Forex Trade with Margin

Various elements of a trader’s account make up the forex trade; we will now look into the effects of the leverage ratio and margin requirement on the elements. For a subtle development of a risk management strategy, it is important to understand the elements that are interlaced among each other.

1. Equity

Equity relates to the total amount of financial backing that is in the trading account. Once a new trading position has been entered the equity will change from its initial point and float in a manner that all unrealized profits and losses will e added and deducted from the total equity respectively.

2. Balance

In the case the trader lacks any open positions on the forex market then the balance of the trading account equals the equity in the account. In a nutshell, profits and losses that haven’t been realized then the balance won’t be affected. The trading account balance will only change if the trades unrealized profit and losses become realized when the trades are closed.

3. Margin

Margin, as stated earlier, depends on the trade opening size and the leverage ratio used.

4. Free Margin

It represents the margin used for leveraged trades subtracted from the equity. 

5. Unrealized Profits and Losses

They relate to all profits and losses made on open positions for a trading account in the forex market. This element impacts both the equity and free margin.

Conclusion

It should be realized that a free margin can estimate the price falls that can be withstood before getting a margin call. It also has an impact on the amount of newly leveraged trades one is allowed to take. The monitoring process of the free margin is therefore critical. Margin trade is quite popular as it allows the trader to open a larger market position than what can be offered by the initial trade account; this, however, comes with collateral being a part of the account.

Published at: 28 Dec 2019 16:15 GMT
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